Lebanon’s official trade deficit looks set to widen in 2019, as fuel imports – likely tied to the ongoing fuel crisis in neighbouring Syria – continue to rise.

This will weigh on the overall current account balance, which we at Fitch Solutions forecast will narrow only marginally from 21.5% of GDP in 2018 to 21.2% in 2019 and 20.1% in 2020.

Lebanese authorities will most likely look to continue covering current account deficits via dollar deposit inflows into local banks.

Such inflows have picked up in recent months amid central bank financial engineering operations; however, waning investor confidence in Lebanon’s economic trajectory raises questions around the longer-term viability of this financing model.

Recent data from the Customs Administration show Lebanon’s goods trade deficit widening to USD8.4bn in H119, up by 4.6% from H118. The widening was driven by a 5.8% increase in imports – specifically mineral (mostly fuel) imports, which rose substantially in volume terms (see chart). This more than offset a 12.1% increase in exports over the same period, primarily driven by the ‘pearls, precious stones and metals’ segment.

Mineral Fuel Imports On The Rise…

Lebanon - Goods Imports, H118 Vs H119 (USDbn)

Source: Lebanon Customs Administration, Fitch Solutions

Local reports suggest the doubling of mineral imports in H119 relative to H118 is linked to acute fuel shortages in neighbouring Syria, which in turn is spurring Lebanese actors to resell fuel products across the border on a large scale. In our view, this explanation seems plausible, as leading indicators such as the Purchasing Managers’ Index have pointed to a steady weakening in Lebanese economic activity throughout the first half of the year. This implies domestic fuel demand is unlikely to have picked up much relative to H118 (see ‘Lebanon's Economic Recovery To Prove Slow, Uneven,’ June 5) – an argument further strengthened by the fact that virtually all other import segments have seen contraction over this period, pointing to sluggish domestic demand more generally.

Assuming this is the case, fuel import volumes will likely remain elevated in the months ahead. In large part, the fuel crisis in Syria has been caused by a slowdown in Iranian supply to the country since late-2018, which in turn is linked to the US (and its allies’) efforts to raise economic pressure both on Tehran and Damascus by blocking their sea trade. We view it as probable that such efforts will continue in the months ahead, as US-Iran tensions remain high and the Assad regime maintains an uncompromising stance towards the US-backed opposition in Syria (see ‘Escalating US-Iran Tensions: What Our Clients Want To Know,’ June 13 and ‘Pro-Syrian Regime Forces' Offensive On Idlib To Push Opposition Forces North,’ August 30). This will limit Damascus’ options for sourcing fuel supply, likely exacerbating shortages and raising fuel prices, thus incentivising Lebanese actors to continue resales across the border.

…Causing The Official Trade Deficit To Widen Again

Lebanon – Goods Trade Balance (USDbn)

Source: Lebanon Customs Administration, Fitch Solutions

As such, we forecast Lebanon’s official goods trade deficit to widen from USD15.1bn (26.1% of GDP) in 2018 to USD16.0bn (26.3%) in 2019. The deficit looks set to narrow again from 2020 on weak domestic demand and lower global oil prices (see ‘Brent: Global Trade Tensions Toppling Prices,’ August 5), but only at a gradual pace, remaining well above 20.0% of GDP throughout the five-year period to 2023. Meanwhile, although services trade and current transfers will likely continue to record net inflows – propped up by tourism and remittances – a weakening outlook for growth globally and especially in key source markets across the GCC, suggest surpluses will only be moderate. Consequently, we forecast the overall current account deficit to remain wide, at 21.1% of GDP in 2019 and 20.0% in 2020, before narrowing gradually to 17.1% in 2023.

Lebanese authorities will look to continue covering persistently wide trade deficits via dollar deposit inflows into local banks. This dynamic has remained in play for several years amid financial engineering operations by Banque du Liban (BdL). These operations entail encouraging local banks to offer attractive interest rate spreads on dollar deposits, and then incentivising banks to place these deposits with the BdL. The latest operation was carried out in July, causing deposit growth, and in turn BdL reserves, to rise (see chart).

Financial Engineering Operations To Boost BdL Reserves, But Only Temporarily

Lebanon - Gross FX Reserves (USDbn)

Source: BdL, Fitch Solutions

That said, waning investor confidence in Lebanon’s current economic trajectory raises questions around the longer-term viability of this financing model. Investor confidence in the Lebanese economy has weakened considerably in recent quarters amid political paralysis and lack of progress on much-needed fiscal consolidation – as evidenced by slowing deposit growth relative to historical levels, and sharp increases in yields on government bonds and widening in spreads on credit default swaps. This raises risks of a more destabilising round of deposit outflows, which in turn would put pressure on BdL reserves and the Lebanese pound’s peg to the dollar. While not our core view, we caution that a failure by the government to implement planned fiscal reforms and stabilise public debt over the coming quarters could trigger the realisation of such risks, particularly if coupled with another period of global ‘risk-off’ sentiment.